May 28, 2012

My wife and I have been gradually home shopping. We're in no rush to buy but still looking since prices are good and interest rates are very low. I was talking to our mortgage guy and he pointed out that the maximum loan before you get to the "jumbo" loan is $417,000. (The limit is higher $625,500 in Alaska, Hawaii, Guam & U.S. Virgin Islands).

Whats a Jumbo loan?

Simply put a jumbo loan is a loan that is larger than the government sponsored FannieMae or Freddie Mac will purchase. Normally Freddie / Fannie will buy loans from banks. To sell a loan to them the bank needs to ensure the loan conforms to standards. Such a loan is a 'conforming' loan. But Freddie/ Fannie won't buy very large loans and the limit is the threshold between a conforming loan and a Jumbo loan. Jumbo loans are the term for loans larger than the amount Freddie/Fannie will buy.

Why do you care?

Jumbo loans are a bit riskier and harder to resell for the banks. Therefore they charge higher interest for a jumbo loan.

How much more do they cost?

The spread between a conforming loan and a jumbo loan is generally between 0.25% and 1%.

Lets look at an example : I compared the rates for a $416,000 conforming loan and a $418,000 jumbo loan on Amerisave. The conforming loan could be had for a 3.625% rate with $404 in points/fees and the jumbo loan was 4.375% with $108 point/fees. Thats a 0.75% spread. The payments were $1897 and $2087 for the conventional and jumbo respectively. Thats a difference of $190 per month at todays low rates. Thats a pretty big deal.

If you can help it you should avoid jumbo loans.

Of course you don't want to pay an extra 0.25-1% on your mortgage if you can help it. So you should do what you can to stay within the conventional mortgage guidelines and avoid jumbo rates.
One tactic is to bring more money towards the downpayment to avoid the higher interest costs. For my example above the loans are on the threshold and the $418,000 loan would cost you $190 less per month if you brought $2000 more to closing to instead borrow just $416,000. Of course few people are borrowing just at the verge of Jumbo rates and its harder to bring $100,000 extra to the table if you want to borrow $515,000. Another way to try and avoid a jumbo rate is to get a secondary mortgage on top of your primary. So if the house costs $600k and you have $120k for a downpayment thats still a $480k loan which is in the jumbo range. If you get a $400k primary loan and a $80k secondary loan then your primary would be a conventional rate loan. Such second mortgages can be harder to qualify nowadays.

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